Error and Fraud in Audit:
You must be knowing that the primary objective of an audit is to express an opinion on the truthfulness and fairness of financial statements. And to form such an opinion, an incidental objective works simultaneously which is to detect and prevent frauds and errors. Unless an auditor establishes that there are no frauds and errors in the books of account, he cannot express his opinion on the true and fair view of financial statements. Thus, locating the possibility of errors and fraud is important.
An error may be defined as an unintentional mistake in the measurement or presentation of financial information. However, fraud refers to an intentional misstatement in financial statements. It may be committed by the client’s employees, the management, or third parties so as to obtain an illegal or personal gain out of the business of the client.
The main difference between an error and a fraud is that of intent. While frauds are committed intentionally, errors are not.
Further, the responsibility of an auditor for detecting errors and frauds is the same as both of them result in misstatements in financial statements. But the distinction between them is important because the existence of fraud raises questions about the integrity of the client’s management and those charged with governance.
Difference between Error and Fraud
In the context of an audit, the following points of difference can be drawn between an error and a fraud:
|Meaning of Error||Meaning of Fraud|
|The term “Error” refers to an unintentional mistake in the measurement or presentation of accounting and/or financial information.||A fraud indicates an intentional misstatement that is material to financial statements. Materiality means that the existence of fraud is such that it can affect financial statements to a large extent.|
|Errors are unintentional.||Frauds are committed intentionally. The objective is to derive some personal gain or an unfair advantage.|
|Types of Errors||Types of Frauds|
|An auditor may come across many types of errors in financial information. These may be clerical errors (i.e., errors in recording and posting of transactions), errors of principle (i.e., failure to comply with generally accepted accounting principles), compensating errors, or errors of duplication where a single transaction is recorded twice.||On the other hand, fraud may take the form of misappropriation of assets, manipulation or falsification of accounts, and so on. The purpose may be to deliberately misrepresent the financial position to evade taxes or to show a better performance of the management than it actually has. Further, it may be either employee fraud or management fraud.|
|Consequences of an error on the audit work||Consequences of fraud on the audit work|
|Once errors are detected, the auditor should ensure that the financial statements are adjusted in regard to them. All material errors should be communicated to the management.||When an auditor identifies or suspects fraud, he should consider its effect on financial statements and communicate to the appropriate level of management. He should examine the reliability of management’s representation in this regard. He should ensure that appropriate disclosure of identified misstatements is made either in the financial statements by management or in his audit report. Finally, he should further consider whether he should withdraw from his engagement.|
|The possibility of detection is more||The possibility of detection is less|
|Errors can be detected more easily.||The possibility of detection of fraud is comparatively less because the management makes conscious attempts to conceal it.|
Auditor’s duty with regard to detection of fraud and errors
Even though the primary responsibility for the prevention and detection of fraud rests with the management, auditors are expected to adopt a careful approach and an attitude of professional skepticism at all times.
According to SA 240, an auditor conducts a financial audit of an entity in order to obtain a reasonable assurance (and not absolute assurance) that its financials are free from any fraud/error and material misstatements.
On identification of misstatements or where the auditor suspects fraud, he must communicate it to the appropriate level of management. If he suspects the management’s involvement in fraud, he must communicate the same to those charged with governance and must discuss with them the nature, timing, and extent of audit procedures necessary to complete the audit.
Moreover, if there is a responsibility to report the occurrence of misstatements to regulatory or enforcement authorities under any law, the auditor must abide by that. For instance, reporting frauds to the Central Government under Section 143 of the Companies Act 2013.
The auditor is also required to consider the implications of fraud and errors, and frame his audit report appropriately. Where there is fraud, the same should be disclosed in the financial statements. If adequate disclosure is not made, there should be a suitable disclosure in his audit report. Whichever way it may be, it is crucial to disclose the existence of fraud and errors, if any.
List of a few references used:
You might also like: